Got a question about the mechanics of investing, how it fits into your overall financial plan and what strategies can help you make the most out of your money? You can write me at beth.pinsker@marketwatch.com.
Dear Fix My Portfolio,
I make $ 75,000 a year and have two teenagers who will be heading to college soon. I have saved a little, but I was counting on getting a lot of help with financial aid. The thing is, my mom just died and I’m about to inherit some money — more than $ 250,000 — and it’s going to land in my account just about when we’re filling out the FAFSA for my oldest in the fall. To make matters more complicated, I’m divorced. My ex makes about the same as me, and doesn’t have much savings. I have the majority of custody and pay most of the bills.
I know I should feel lucky to receive an inheritance, but I feel sad about my mom and now it’s making me worried that college is going to be very, very expensive. Is there a way for me to receive this money and hide it, so it doesn’t just go straight to paying tuition? I wanted to have a little left over for helping with my mortgage and my own retirement. The money is coming in cash, not an IRA or anything.
—CG
Dear CG,
I’m very sorry for your loss. Inheritances come with all sorts of tricky feelings, and sometimes they create financial complications rather than solving them. This situation actually happens in a lot of families. Financial adviser Beth V. Walker, author of “Never Pay Retail for College,” says she sees this scenario with inheritances impacting financial aid about twice a year in her practice.
She helped one family a few years ago where the father died right before the daughter went to college and she got a life insurance settlement. “She was headed toward an almost full need-based award, but then she got $ 350,000 and college was suddenly going to be full-pay that year,” says Walker. “When you’re in that situation, you have to take action to protect it.”
What does that look like? You have a couple of choices.
Divert the funds
One avenue to consider is to spend down the amount you inherit before the financial-aid forms are due. “You could pay off debt,” says Paul Sydlansky, a certified financial planner with Lake Road Advisers in upstate New York and member of the Wealthramp network of advisers. “Let’s say you have a car loan, a mortgage, maybe even the parents have their own student debt.” Pay that all down before the forms are due, and it helps the issue. That also goes if you have any large purchases you were planning, like a vacation or a home renovation.
But take into consideration that the financial aid formula doesn’t just automatically expect you to spend every penny you have on hand. “You have to think about how much it is really going to impact the financial aid numbers,” says Sydlansky.
The financial aid algorithm puts the most weight on parental income, and if that hasn’t changed despite the inheritance, then the bulk of your tuition bill will be based on that. Colleges generally value parental savings and investments at 5.6%, which means if you tell them you have $ 250,000 in savings, they’d expect you to use about $ 14,000 of it a year toward tuition.
When you’re divorced, the federal FAFSA form only counts the income and assets of the parent who pays the majority of the expenses, starting next year, so that would have to be you. For private colleges that use the CSS Profile, both divorced parents have to submit.
So that’s not such bad news, and doesn’t require any subterfuge. If you put your full inheritance in your bank account, and accurately note it on the forms for the 2024-2025 school year, which will open in December 2023, you might still possibly get some financial aid. That’s especially true if you write a letter of explanation to the financial-aid office explaining that your savings have been bolstered temporarily by a one-time inheritance and your overall financial situation has not changed otherwise.
“You disclose the windfall and then go through the windfall appeals process. I see that often,” Walker says.
Chase merit
If you don’t get what you think you need just from need-based aid, you can always look for colleges that will charge you less based on the merit of your child. This is where Walker and Sydlansky help clients strategize the most, because their typical clients are higher income, but they still need to look for breaks off colleges that list at $ 80,000-plus per year. For high-school seniors, the choice of where to apply really matters, and advisers can crunch the data based on each family’s financial picture.
“It allows you to compare apples to apples when it comes to cost and aid,” says Sydlansky.
If you can come up with a college choice for your child that gets them merit aid, then you won’t have to worry about the impact of the inheritance. For clients, Sydlansky runs the numbers on what various colleges are likely to cost using subscription-based professional software. If you’re doing this on your own, you can use the federal student aid estimator to see what FAFSA schools might charge you. For private colleges that use the more complicated and opaque CSS Profile to determine awards, you need to go to each college’s website and run their net price calculator using different asset amounts to see how your bill might be impacted.
You won’t really know, however, until you hear directly from the financial-aid office and see what other scholarship are available that are not dependent on your finances.
If none of this appeals to you, and you think that your inheritance will push the cost of college past your limits, you can try some strategies that advisers use for very large inheritances. For some families, Walker has suggested investing inheritances into retirement and insurance accounts that don’t count toward the financial aid formula. When you’re inheriting cash, it’s not possible to put large sums into an IRA or other qualified retirement plans, but you can invest in annuities and life insurance products, even into specialized life insurance products called modified endowment contracts.
Walker helped one family where a grandparent died and the family invested the inheritance in a universal life insurance policy. But the rules are complicated so, Walker says, “you want to work with somebody who knows how to design them and minimize payday to agent and cash to client.”
When it comes down to it, you may well decide that trying to exclude your inheritance from the financial aid formula may not be worth the effort and it’s best just to use the funds to pay for education costs. “I’m not a fan of whole life or universal life as an investment vehicle,” says Sydlansky. “The fees are hard to understand and it’s designed to protect you, not make money on it.”